Financial institutions are inundated with subpoena requests from government agencies for records of account holders and financial transactions. =While responding to those routine third-party subpoenas has its operational costs, such compliance costs can be increased significantly when the financial institution learns it has been victimized by customer fraud, and even more so if that fraud was perpetrated with the assistance of a financial institution employee. When such unfortunate circumstances arise, financial institutions routinely employ outside counsel to initiate an internal investigation of the activities of their employee and their customer. As a victim, financial institutions often received a restitution order against the fraudster for the costs of their internal investigations.
On May 29, 2018, in Lagos v. United States, the Supreme Court of the United States held that mandatory restitution laws do not require convicted fraudsters to reimburse the victim for company initiated internal investigations into their activities. Lagos overturned the law in many areas of the country that allowed such a recovery for victims of fraud.
To understand the implications of this decision on conducting internal investigations in the future, it is important first to understand the facts of the case. Defendant Lagos owned a logistics business through which he defrauded his lender by creating false invoices for services never performed by his business and using the “fake” receivables as collateral. Once the lender learned of the fraud, it conducted an internal investigation. The lender then provided its findings to the government, who indicted Lagos on wire fraud.
After conviction, the government argued that Lagos was required to pay the lender restitution for its losses that included expenses the lender incurred investigating the fraud and participating in Lagos’ bankruptcy proceedings. The government claimed that the lender was due this restitution under the Mandatory Victims Restitution Act. This federal law requires that defendants convicted of certain crimes pay the victims of their crimes for certain losses incurred.
The portion of the Act at issue in the case states that the criminal is to “reimburse the victim for lost income and necessary child care, transportation, and other expenses incurred during participation in the investigation or prosecution of the offense or attendance at proceedings related to the offense.” 18 U.S.C. § 3663A(b)(4) (2012) (emphasis added). When the trial court and the Fifth Circuit ordered Lagos to pay the lending institution’s internal investigation expenses, which totaled approximately $5.0 million, Lagos appealed to the Supreme Court. He requested that the Court narrowly interpret the bolded words above and determine if the statute applies to government investigations and criminal proceedings only, or if it also includes restitution for private entities that conduct internal investigations of wrong doing.
The Supreme Court determined that the words “investigation” and “proceedings” only apply to governmental investigations and proceedings, and therefore determined that Lagos did not owe the lender restitution payments for its costs expended during its private internal investigation of Lagos. The Court stated four reasons for its decision. First, the Court examined the wording of the statute. Given that “investigation” was separated from “prosecution” by an “or” led the Court to believe that these two words were intended to be substitutes for each other. Therefore, the word “investigation” is limited by the word “prosecution,” which inherently refers to a governmental prosecution. Since the word “proceedings” immediately follows the word “prosecution,” the Court determined that the Legislature intended to limit “proceedings” in the same way.
Second, the Court looked to the use of the words “participation” and “attendance” as used to describe the victim’s role in the investigation and proceedings. The Court reasoned that a private party does not “participate” or “attend” its own investigations or proceedings, however, it would “participate” in or “attend” an investigation or proceeding that the government conducted.
Third, the Court reasoned that the compensation listed in the statute is more reasonably related to the costs that a victim would incur by cooperating with a government investigation or proceeding. Lost income, child care expenses, and transportation expenses are much more likely to be incurred by a victim who is missing work or traveling to participate in a governmental proceeding, and not likely to be incurred if he or she is conducting his or her own private internal investigation. Additionally, the statute makes no mention of costs that a victim would accrue through private investigations, such as attorney’s fees.
Fourth, the Court looked to the practicalities of a court proceeding applying this statute; if this statute was read to include restitution for private investigations, the word “necessary” as used in the statute would induce additional litigation. Too much time would be wasted trying to determine if the expenses a private party sustained during its investigation were “necessary.”
The Court did consider the government’s counter arguments in favor of reading restitution for private internal investigations into the Act, but ultimately rejected them. Though the government suggested that this narrow reading of the statute may leave victims without restitution, which is contrary to the purpose of the Act, the Court rebutted by stating that other federal restitution acts have specific language allowing for a victim to recover fully, which this Act does not contain. If Congress had intended full recovery, it would have written it into the statute, rather than limiting it to the listed categories. Additionally, private individuals can always pursue civil litigation, as the lender did in Lagos, to collect on its investigation expenses.
The Government also argued that the lender in Lagos should be reimbursed because it provided its information from its internal investigation to the government. The Court rejected that argument as well. The expenses at issue in the case were the ones that the lender incurred while investigating Lagos’ fraud, not during the government’s investigation. The Court declined to address whether a private party could be reimbursed for expenses incurred while conducting an internal investigation or proceeding at the request of the government.
In light of Lagos, what can a victimized financial institution, who has incurred professional investigatory and legal expenses, do to be reimbursed from the fraudster for such costs? Post Lagos, the options are limited. Nonetheless, the benefits of conducting an internal investigation still outweigh the reduction in potential recovery.
First, it would be a mistake to overread the Court’s decision in Lagos and wait to conduct an internal investigation until hearing from or at the request of the government. While recovery of the expenses of doing so may now be limited, the fundamental purposes of conducting an internal investigation to: (a) enable senior management and the Board of Directors to be adequately informed about a matter for exercising their fiduciary duties of care, (b) allow the financial institution to remedy the issues that led to misconduct and recommend appropriate corrective actions, (c) have the facts at hand to facilitate resolution with government agencies and regulators when they do become involved, and (d) provide the Board with full knowledge to have protections of the business judgment rule, still remain the main reasons for a financial institution or other corporate entity to conduct an internal investigation. Practically speaking, as the Supreme Court noted in Lagos, more than 90% of criminal restitution is never collected for the benefit of the victims anyway.
Second, in a case in which the fraudster may in fact be collectible, it would be in the interest of the financial institution to involve the government earlier in the process of the internal investigation to allow the financial institution to make a good faith argument that the remainder of the investigation was done at the request of the government which would allow the costs and expenses incurred to potentially still be recoverable despite the limitation in Lagos.
Third, consistent with the U.S. Department of Justice’s principles of federal prosecution relating to business organizations, conducting an internal investigation regarding serious fraudulent conduct by an employee in conjunction with a borrower, remedying any internal control issues, and cooperating with the government in doing so remains one of the best defenses for the financial institution to being held criminally responsible for the conduct of the rogue employee in such a fraudulent scheme.
Finally, nothing in Lagos eliminates the ability to recover the costs of your internal investigating through other means. Civil claims against the fraudster remain available. Recovery under insurance policies also often provides the best road to recoup costs.
Michael Best Summer Associate Amy Lewandowski assisted in the creation of this article.